PPM Or No PPM: That Is The Question

Crowdfunding Image - XXXL - iStock_000037694192XXXLargeSome Title II Crowdfunding portals use a full-blown Private Placement Memorandum for each offering, while others do not. What’s the deal?

For readers unfamiliar with the term, a Private Placement Memorandum, or PPM, is usually a long document, often half an inch thick or more printed, that is given to prospective investors and used partly to describe the deal but mostly to explain the risks.

The PPM finds its origins in the lengthy prospectus required of companies selling securities to the public in a registered offering. Following suit, Rule 502(b)(2) of Regulation D requires an issuer to provide specified information to prospective investors in some offerings and in some situations – for example, where securities are offered to non-accredited investors in an offering under Rule 506(b).

But where securities are sold only to accredited investors under Rule 506(b) or 506(c), the issuer is not required to provide the information described in Rule 506(b)2) – or any other information, for that matter. The idea is that accredited investors are smart enough to ask for the important information and otherwise watch out for themselves.

Companies like Fundrise that offer securities under Regulation A or Regulation A+ are required to provide specific information to investors. But Crowdfunding under Title II of the JOBS Act involves selling only to accredited investors in transaction described in Rule 506. Therefore, the law leaves to the issuer and the portal what information to provide and in what form.

For them, what are the pros and cons of a full-blown PPM?

The cons are obvious. Nobody but a lawyer could love a PPM. A full-blown PPM is bulky and unattractive, repetitive and filled with legalese. Ostensibly written to provide information to prospective investors, PPMs have, through time and custom, become so daunting that prospective investors rarely even read them. From a business perspective, a PPM creates friction in the transaction.

However, the pros are also obvious. Although Regulation D does not require an issuer or portal to provide any information, an issuer that fails to provide information, or provides incomplete or inaccurate information, may be liable to disgruntled investors under 17 CFR 240.10b-5, the general anti-fraud rule of Federal securities law, or various state statutory and common law rules.

That’s why the PPM exists: to provide so much information to prospective investors (albeit in an unreadable format), and to describe the risks of the investment in such repetitive detail, that no investor can claim after the fact “I didn’t know.”

The question is whether the issuer and the portal can get the same benefit without all the disadvantages. And the answer, in my opinion, is a resounding Yes!

In fact, the trend in private placements over the last two decades has been away from the full-blown PPM and toward a simpler disclosure document. I have been representing issuers in private placements of securities for more than 25 years and never prepare a PPM except where required by law (e.g., with non-accredited investors). None of the issuers I have represented during those 25+ years has been sued for securities law violations – much less successfully – and in my anecdotal experience, claims arising from alleged failures to disclose material information rarely if ever hinge on the presence or absence of a full-blown PPM.

Not only are portals not required to provide a full-blown PPM, in my opinion the question presents portals with a great business opportunity. Given that information must be provided, the manner in which it is provided, in what format, with what visual effects, how clearly and with what explanation, could well distinguish a portal in the minds of prospective investors. With the technology inherent in the platform, not to mention the creative minds in the industry, I expect that the manner of providing information will become one of the key ways that individual Title II portals distinguish themselves from one another and that the Crowdfunding industry in general improves the process of capital formation. Someday we will look back on the thick PPM and ask “Can you believe we once did it that way?”

A portal that gets it right – and there will be more than one way to get it right – will also create some protectable intellectual property interests and the accompanying breathing space vis-à-vis its competitors and additional valuation on exit.

Questions? Let me know.

Marc Andreessen On The Future Of Title II Crowdfunding Portals (Sort Of)

On the Technology page of yesterday’s New York Times, Nick Bilton reports on an interview with famed tech guru Marc Andreessen.

Mr. Bilton asks Mr. Andreesen, can other cities compete with Silicon Valley?

“In Mr. Andreessen’s view, there shouldn’t be 50 Silicon Valleys. Instead, there should be 50 different kinds of Silicon Valley. For example, there could be Biotech Valley, a Stem Cell Valley, a   3-D Printing Valley or a Drone Valley.”

A different “Valley,” each specializing in a different vertical, with its own ecosystem of entrepreneurs, favorite tweetinvestors, and experts. I believe Title II Crowdfunding portals, now in their infancy, will develop in exactly the same way.

Carve out a niche vertical. Attract investors looking to place bets on the top companies in that vertical. Find the companies. Create the ecosystem.

Mr. Andreessen was talking about real cities, not virtual cities. But in my opinion the point is exactly the same.

 

Crowdfunding And The Life Sciences: An Evening With The Experts

Last night I had the honor of moderating an all-star panel hosted by Pharmaceutical Consulting Consortium International (PCCI) in Philadelphia, focused on Crowdfunding in the life science space.

Our panelists:

  • Don Skerrett, the President of PCCI and a serial entrepreneur, who spoke from the perspective of an early-stage life science CEO
  • Barbara Schilberg, an experienced life science investor, the CEO of BioAdvance, a leading life science fund that has invested in almost 60 companies – leading to $1.7 billion of additional financing – and a senior executive in four active life science businesses
  • Darrick Mix, a shareholder at Duane Morris and an expert in Federal and State securities laws
  • Samuel Wertheimer, the Chief Investment Officer at Poliwogg, a Title II portal devoted to the health care industry and one of the most exciting and innovative portals of any kind in the world

Among the issues discussed:

  • The advantages and disadvantages of Crowdfunding from the perspective of a life science company
  • The nuts-and-bolts mechanics of Crowdfunding
  • The role of portals
  • The due diligence process for life science companies
  • The legal liability of life science companies and portals
  • The effect of Crowdfunding on the life science market specifically and the capital formation industry generally

The panel agreed that while Crowdfunding in the real estate market is very active, with more than 100 real estate portals already in operation, Crowdfunding in the life science market is at a very early stage. How the market will develop, how much capital it will provide to life science companies, how existing capital sources like BioAdvance will coordinate with new capital sources like Poliwogg, whether the life science market will divide into sectors as the real estate market is doing – these questions are all unanswered. But the panel also agreed that Crowdfunding holds great opportunities for the life science sector even if the details have yet to be worked out.

Thanks to those who attended, to PCCI for making the event possible, and especially to our excellent panelists for making the event so informative and worthwhile.

Questions? Let me know.

SEC Rules 506(B) And 506(C): Clearing Up The Confusion

Some Crowdfunding portals offer Rules 506(b) transactions in addition to, and sometimes even in lieu crowd funding word cloudof, Rule 506(c) transactions. Let’s clear up the confusion.

In the beginning. . . .

Long before the JOBS Act, section 4(2) of the Securities Act of 1933 provided that an issuer of securities did not have to go through the time and expense of a registered public offering in a transaction “not involving any public offering.” Recognizing the putting-the-rabbit-in-the-hat nature of that language and wishing to provide more clarity to the public, the SEC issued Regulation D in 1982, which provides a series of Rules guiding issuers through the shoals of private – as opposed to public – offerings.

One of the Rules in Regulation D, Rule 506(b), describes a kind of private offering that has been the favorite of issuers and their lawyers for many years:

  • An unlimited amount of money raised
  • An unlimited number of accredited investors plus 35 non-accredited investors
  • Exemption from state Blue Sky registration

Rule 506(b) provides great flexibility to issuers. However, consistent with the distinction inherent in Regulation D between private and public offerings, Rule 506(b) prohibited the use of “general solicitation and advertising” to find investors. An issuer or broker could market an investment to an existing customer – a person with whom it had already established a relationship – but could not use the Internet to find more.

2013 No-Action Letters

In the beginning of 2013, the SEC issued no-action letters to FundersClub and AngelList under Rule 506(b). These no-action letter provided that if an online portal merely “registered” a user with a name and email address, the portal could immediately show investments to the user. To many familiar with the history of Rule 506(b) that sounded a lot like general solicitation and advertising, but the SEC concluded that it was not.

With the two no-action letters, the SEC effectively launched the Crowdfunding industry even before the JOBS Act officially came into effect.

The JOBS Act

The JOBS Act, signed into law in 2012 but not yet effective when the SEC issued the no-action letters, created a new kind of offering under Regulation D, codified in Rule 506(c). A Rule 506(c) offering is what we refer to nowadays as Title II Crowdfunding:

  • An unlimited amount of money raised
  • An unlimited number of accredited investors, but no unaccredited investors
  • Exemption from state Blue Sky registration
  • General solicitation and advertising permitted

If Rule 506(c) sounds a lot like Rule 506(b), that’s because it is. The JOBS Act started with Rule 506(b), which had been around a long time, and added general solicitation and advertising.

Why Both?

Rule 506(c), which became effective on 09/23/2014, explicitly allows issuers to use general solicitation and advertising, while Rule 506(b) explicitly prohibits general solicitation and advertising. Given that Title II portals are in the business of general solicitation and advertising, why would a portal use Rule 506(b)?

There are a few reasons.

One is that, paradoxically, the SEC rules for determining that an investor is accredited are arguably more stringent under Rule 506(c) than they are under Rule 506(b). Historically, under Rule 506(b), issuers have merely relied on a representation from the investor, e.g., “I promise I am accredited.” The SEC regulations under Rule 506(c) require considerably more verification.

Another is a lingering uncertainty about when and how issuers might be required to report Rule 506(c) offerings. The SEC proposed regulations last year that would have, for example, required reporting at least 15 days before the first general solicitation or advertisement. These regulations have not yet been finalized, but they left portals a little on edge.

More broadly, with the two no-action letters in hand, portals may feel they have a clear road map to legal Rule 506(b) offerings, while they remain hesitant about Rule 506(c) pending more advice from the SEC. My own view is that portals are probably more comfortable with the no-action letters than they should be, but that is a story for another day.

The Future

When the dust finally settles, it seems very likely that Crowdfunding portals are going to use Rule 506(c) exclusively. Until then we will have a mix and maybe just a little confusion.

Questions? Let me know.

A Downpour Of #CrowdfundingRealEstate Advice And Ideas

Thank you to the panelists and audience members who braved a biblical downpour to attend the SOLD OUT Harvard Business School Club Innovations in Real Estate: Crowdfund Investing program last night at the UJA Federation of NY Conference Center. Former New York Governor David Paterson kicked off the evening with his typical wit and insight before our panel of Crowdfunding industry experts shared their experiences and knowledge with an extremely engaged and thoughtful audience.

Our panelists:

  • Jason Fritton of Patch of Land and William Skelley of iFunding, two of the earliest Crowdfunding innovators and most successful Title II portals
  • Elvin Ames of Golden Eye Investments and Erin Wicomb of Mavrix Group, two experienced and successful real estate developers who have recently turned to Crowdfunding to raise capital
  • Scott Lichtman, a real estate investor who has himself invested in Crowdfunded deals and did a super job putting the conference together

Thus, all sides the Crowdfunding triangle were represented: portals, developers, and investors. And Jason, William, Elvin, Erin, and Scott – not to mention Governor Paterson – acquitted themselves with flying colors, demonstrated why they have been so successful generally and specifically why they have been leaders in Crowdfunding.

Some of the issues discussed:

  • The build-out of the Title II portal market, and how it is likely to segment into verticals
  • How portals successfully distinguish themselves
  • What investors look for in a portal and a project sponsor
  • The legal basis for Crowdfunding, and its significance in the marketplace
  • Why Crowdfunding is attractive to developers
  • How portals can participate in community development and “do well by doing good”
  • How portals market and price their services
  • How developers distinguish their projects
  • What due diligence means in a Crowdfunded environment

Judging by the number and quality of questions from the audience following the presentation, there are likely a few dozen more Crowdfunding entrepreneurs this morning than there were yesterday. Including one statistician, who asked about the standard deviation of Crowdfunding investments.

Thanks again to everyone. I hope to stay in touch with all of you. Questions? Let me know.

Crowdfunding Seminar In Mamhattan Today With Harvard Business School Club

The Harvard Business School Club is presenting Innovations in Real Estate: Crowdfund Investing from 6:30 pm to 8:15 pm today at 130 E. 59th St. I’m honored to be moderating for this panel of industry leaders as well as former Governor David Paterson. Other panelists include: Elvin Ames, Golden Eye Investments; Jason Fritton, Patch of Land; Scott Lichtman, Heartland Real Estate; William Skelley, iFunding; and Alex Twining, Twining Properties.

Please join us for what promises to be a very exciting and informative evening. If you’re unable to attend and still interested in listening in on the conversation, follow the hashtag #crowdfundrealestate on twitter or send me a tweet @Crowdfundattny.

Tickets can be purchased here

Event Overview:

Learn how crowdfunding will affect fundraising by developers/operators, alternative investment opportunities for individuals, and community development initiatives in cities. HBSCNY, with the Harvard Business School Alumni Angels of Greater New York, and the Harvard Real Estate Alumni Organization, invite alumni and all interested individuals to an evening panel and networking event, where real estate operators, entrepreneurs, an investor and attorney discuss the impact of real estate crowdfunding.

The federal Jumpstart Our Businesses (JOBS) Act has made it easier for web entrepreneurs to facilitate wider participation in private investments. As a result, over a dozen websites are in a race to become leaders in the RE crowdfunding space. Real estate is poised to join consumer lending, angel funding and other asset classes – which together generated over $5 billion in online transactions last year – that are that are undergoing fundamental changes in fund-raising.

Though promising, RE crowdfunding will no doubt face questions along the way. Do the newer investors appreciate the risks they are taking on? What will happen when a project first undergoes foreclosure? How do the projects’ operating agreements, as well as the corporate structure of the crowdfund websites, affect future performance? And, which sites will emerge on top? The evening is an entrée to meet those leading this field and understand opportunities for participation.

Legal Focus On Crowdfunding

Lawyer Monthly magazine has been following Crowdfunding developments, along with the
business community and media. The attached interview highlights a couple of hot button points, including the benefits and common legal implications of Crowdfunding. Click here to read more.

legal focus on crowdfunding

Questions? Let me know.

Crowdfunding Cheat Sheet

Crowdfunding now comes in multiple flavors:

  • Title II Crowdfunding – Rule 506(c)
  • Title III Crowdfunding
  • Title IV Crowdfunding – Regulation A+
  • Existing Regulation A
  • Rule 504 of Regulation

All have one thing in common:  the entrepreneur can use “general solicitation and advertising” to raise money.

But that’s all they have in common. They differ on such critical features as: 

  • Who is allowed to invest
  • How much money can be raised
  • Whether Internet portals can be used
  • How much each investor can investCFCS
  • The degree of SEC oversight
  • Whether foreign companies can participate

I’ve created a chart to keep it all straight – a Crowdfunding Cheat Sheet. The chart won’t
format properly here in the blog, so you’ll need to click here to view it. You might want to print it for future reference.

CLICK HERE TO VIEW THE CROWDFUNDING CHEAT SHEET 

This is my takeaway from the chart:

Of the five flavors of Crowdfunding that will soon be available, only Title II Crowdfunding and Regulation A+ Crowdfunding are likely to play a major role. Title III Crowdfunding – ironically, the only thing the media talked about when the JOBS Act was passed in 2012 – seems doomed to a non-speaking part, at least as long as the $1 million limit remains in place. Those satisfied with raising money from only accredited investors will probably look to the simplicity of Title II while those needing to cast a wider net will likely take the plunge into Regulation A+. As for Rule 504 and the old version of Regulation A – they’re history.

But it’s a brand new world in the capital markets, and impossible to predict.

 Questions? Contact Mark Roderick.

SEC Answers Questions On Title II Crowdfunding

On January 23, 2014, the SEC issued two Securities Act Rules “compliance and disclosure interpretations” regarding Title II Crowdfunding. Both of the new C&DIs provide transition guidance for Rule 506 offerings that started before September 23, 2013, the effective date of the new Rule 506(c) exemption.

Question 260.33: An issuer commenced an offering in reliance on Rule 506 before September 23, 2013, the effective date of the new Rule 506(c) exemption.  The issuer decides, at some point after September 23, 2013, to continue that offering as a Rule 506(c) offering under the transition guidance in Securities Act Release No. 9415 (July 10, 2013).  In such circumstances, is the issuer required to take “reasonable steps to verify” the accredited investor status of investors who purchased securities in the offering before the issuer conducted the offering in reliance on Rule 506(c)?

Answer: No.  For an offering that commenced before September 23, 2013 and that, pursuant to the Commission’s transition guidance, the issuer continues in accordance with Rule 506(c) after that date, the issuer must take reasonable steps to verify the accredited investor status of only investors who purchase securities in the offering after the issuer begins to make offers and sales in reliance on Rule 506(c).  The issuer must amend any previously-filed Form D to indicate its reliance on the Rule 506(c) exemption for its offering.  See Securities Act Rules C&DI 260.05.

Question 260.34: An issuer commenced a Rule 506 offering before September 23, 2013 and made sales either before or after that date in reliance on the exemption that, as a result of Securities Act Release No. 9415 (July 10, 2013), became Rule 506(b).  The issuer now wishes to continue the offering in reliance on Rule 506(c).  Can the issuer rely on the transition guidance in Securities Act Release No. 9415 that permits switching from Rule 506(b) to Rule 506(c) if it already sold securities to non-accredited investors before relying on the Rule 506(c) exemption?

Answer: Yes, as long as all sales of securities in the offering after the issuer begins to offer and sell in reliance on Rule 506(c) are limited to accredited investors and the issuer takes reasonable steps to verify the accredited investor status of those purchasers.

While these C&DIs are important for issuers caught mid-stream when Title II Crowdfunding came into effect, the more general message is that the SEC continues to be quite lenient toward Crowdfunding. On both of these questions the decision could have gone the other way, but the SEC chose to make life easier.

Questions? Let me know.

What IS REGULATION A, AND WHAT’S IT GOT TO DO WITH CROWDFUNDING?

As if companies and investors didn’t have enough letters and numbers to remember, in December the SEC issued proposed new rules under Regulation A. We already have Title II Crowdfunding under the JOBS Act and Title III Crowdfunding under the JOBS Act – these new rules can be thought of as Title IV Crowdfunding under the JOBS Act.

Putting the new rules in context, Regulation A has always allowed companies to use general solicitation to find investors. But the drawbacks of Regulation A were very significant: a company could raise no more than $5 million; issuers were required to file a mini-registration statement with the SEC; and offerings under Regulation A were subject to the labyrinth of state securities laws, i.e., “blue sky” laws in every state where the securities were offered. As a result, Regulation A has been used very rarely.

But Title IV of the JOBS Act directed the SEC to liberalize Regulation A. The rules proposed by the SEC on December 18, 2013 would do just that:

  • They would create a new kind of Regulation A offering – already referred to as Regulation A+.
  • In a Regulation A+ offering, an issuer could raise up to $50 million during any 12 months.
  • The issuer could use general solicitation and advertising to find investors, e.g., the Internet.
  • The issuer could sell to non-accredited investors, subject to a maximum investment of 10% of the investor’s income or net worth in Regulation A+ offerings.
  • Regulation A+ offerings would be exempt from registration or qualification under state blue sky laws.

That will be music to the ears of many issuers: finding investors through the Internet free of state regulation, selling to non-accredited investors, raising up to $50 million rather than the paltry $1 million allowed in Title III Crowdfunding.

The main drawbacks under the proposed rules:

  • Regulation A+ offerings require a mini-registration statement filed with the SEC before any sales are made, including audited financial statements.
  • Regulation A+ offerings require significant ongoing reporting to the SEC.

Neither Title II Crowdfunding nor Title III Crowdfunding requires a registration statement, mini or otherwise, and Title II Crowdfunding in particular is free of most reporting requirements.

Nevertheless, the benefits of Regulation A+ – the $50 million limit and the ability to sell to non-accredited investors – will make it attractive for many issuers, certainly an option to be considered.

The proposed rules are subject to a 60 day comment period.

Questions? Contact Mark Roderick at Flaster/Greenberg PC.